Auditing the central bank: a jolly good thing!

What is so important about H.R. 1207: the Federal Reserve Transparency Act of 2009 aka the ‘Audit the Fed’ bill? This bill “To amend title 31, United States Code, to reform the manner in which the Board of Governors of the Federal Reserve System is audited by the Comptroller General of the United States and the manner in which such audits are reported, and for other purposes.” may not sound terribly exciting, but in addition to making the Fed accountable for its quasi-fiscal activities, it could well set an important precedent for the enhanced accountability of operationally independent central banks everywhere.

The Finance Committee of the US House of Representatives has just passed this bill, which is an amendment sponsored by Representatives Ron Paul (Republican) and  Alan Grayson (Democrat) to Representative Barney Frank’s HR 3996, the “Financial Stability Improvement Act of 2009″. The amendment allows the US Government Accountability Office to conduct a wide-ranging audit of the financial activities of the Federal Reserve Board.  Specifically (and quoting from the website):

The Paul/Grayson amendment:

  • Removes the blanket restrictions on GAO audits of the Fed
  • Allows audit of every item on the Fed’s balance sheet, all credit facilities, all securities purchase programs, etc.
  • Retains limited audit exemption on unreleased transcripts and minutes
  • Sets 180-day time lag before details of Fed’s market actions may be released
  • States that nothing in the amendment shall be construed as interference in or dictation of monetary policy by Congress or the GAO.

This is the first time an external agency will be able to audit the Fed’s financial arrangements with foreign central banks and with major US banks and other financial institutions, such as AIG. There are times one has strange company when supporting a worthy cause.  Support for extending the GAO’s mandate came among others from the usual army of Fed bashers, led in the Congress by Representative Ron Paul (one of the co-sponsors of the measure), and by a motley crew of paranoid conspiracy theorists of the Lyndon LaRouche variety, who accuse the Fed of being behind every evil financial deed committed or suspected of having been committed, and may well believe it is a front for the House of Windsor or the Elders of Zion.

Well, I’ll just have to hold my nose and remind myself that even a broken clock points to the right time twice a day.  A comprehensive independent audit of the Fed’s use of what is, in the final analysis, public money and therefore tax payers’ money is long overdue.  This is a major victory for democracy and the public’s right to know what those to whom certain public functions have been delegated and entrusted have been doing with the taxpayers’ money.

Let’s face it, nobody and no institution likes being at the receiving end of greater openness, transparency and accountability.  Accountability is a noble cause when you want to impose it on others, but an infernal nuisance when you are subject to it.

The amendment that was passed expressly forbids the GAO or the Congress from interfering with the Fed’s independence in managing monetary policy, that is, in setting interest rates and providing liquidity support to markets and institutions.  And there is no reason why even thorough, indeed intrusive scrutiny of the Fed’s financial transactions would interfere in any way with the independent pursuit of its monetary mandate.  Those who argue otherwise are merely asserting that the wrong set of people – a bunch of shrinking violets – have been appointed to the Federal Reserve Board.

What’s good for the Fed and for American democracy is equally important for the European Central Bank and European democracy or for the Bank of England and British democracy.  The ECB has been running a massive cash-for-clunkers scheme for Euro Area banks since August 9, 2007 (perhaps it should be referred to as the ECB’s ‘cash-for-clankers’ or ‘cash for bunkers’ scheme).

It has done this by accepting as collateral in repos and other collateralised loan transactions conducted with eligible Eurosystem counterparties by the 16 national central banks (NCB) that together with the ECB make up the Eurosystem, an astonishingly wide variety of private securities, including illiquid ABS (asset-backed securities such as residential mortgage-backed securities (RMBS).  The terms on which this collateral was accepted by the NCBs are not in the public domain in the case when this collateral was illiquid.  In the absence of an acceptable market price guide to valuing the collateral, the ECB specifies that a technical price is used, based on internal models and other valuation methods that are private to the Fed.

Despite repeated requests by me to members of the Executive Board of the ECB and to Governors of NCBs belonging to the Eurosystem, neither the internal models used to value illiquid collateral, nor the actual valuations assigned to specific securities offered as collateral have been put in the public domain.  This amounts to an outrageous and arrogant denial of the Eurosystem’s duty to account to the European Parliament and to the European citizens at large for its use of tax payers’ money.

We have good reasons to suspect that the terms on which the Eurosystem has made collateralised funds available to the Euro Area banks (including many subsidiaries of banks headquartered outside the Euro Area) have included a significant quasi-fiscal subsidy.  Banks all over the Euro Area, notably Spanish, Dutch and Irish banks, but also, before the fall, Euro Area subsidiaries of Lehman Brothers and the Icelandic banks, bundled and wrapped large amounts of securities they could not use as collateral anywhere else, and presented the resulting rubbish to the Euro Area NCBs as collateral for central bank liquidity.

Even if the acceptance of such over-valued rubbish collateral is the right thing to do, from the perspective of the greater public good of systemic financial stability, there must be transparency about the magnitude of the ex-ante and ex-post quasi-fiscal transfers involved.  The ECB is the custodian of public funds.  In this fiduciary capacity, it owes a duty of care to the European citizens.  And whether or not it fulfils its fiduciary duties appropriately cannot be based on blind faith and unquestioning trust in the inherent goodness and wisdom of the ECB.

It is time for a detailed and comprehensive independent audit of the ECB’s financial transactions since the beginning of the crisis.  This should include a close examination of the precise terms and conditions, including valuations of illiquid collateral, on which liquidity support, including enhanced credit support, has been made available to the Euro Area banks by the NCBs of the Eurosystem.

I want to be clear about what I mean by an independent audit of the ECB and the Eurosystem.  The ECB reports on its finances and has its annual accounts scrutinized by outside auditors (as per Aricle 109 B (3) EC Treaty and Articles 26 and 27, ESCB Treaty).  This makes sure things add up and there is no evidence of fraud and malfeasance. The ECB is not subject to the full scrutiny of the European Court of Auditors, the panel of financial experts that examines the revenue, expenditures, management, and overall efficiency of the European Union’s bureaucracy.  The Court of Auditors only examines the ‘operational efficiency’ of the management of the ECB (Article 27.2 ESCB Statute) and has thus far used a very narrow interpretation of the concept of ‘operational efficiency’.

Clearly, the job of auditing the ECB for the proper use of its financial resources cannot be performed by an internal unit of the ECB itself, such as its Internal Audit Directorate or its Audit Committee. Following the precedent set by the 2003 decision of the European Court of Justice in the OLAF case brought by the European Commission against the ECB (where the ECJ rejected the ECB’s claim that it had the right to set up its own independent anti-fraud regime and that it did not fall under the regime established by the European Regulation concerning investigations conducted by the European Anti-Fraud Office (OLAF)), I would deepen and broaden the mandate of the European Court of Auditors as regards its audit of the ECB’s accounts.

There is no reasonable argument that confidentiality concerns and the defense of its monetary policy independence would preclude the same kind of scrutiny of the accounts of the ECB by the Court of Auditors that is granted the US GAO in the Federal Reserve Transparency Act. The results of this enhanced investigation/audit of the accounts of the ECB by the Court of Auditors should, with due regard for reasonable confidentiality concerns, be in the public domain.

This kind of detailed and comprehensive independent audit should become a regular part of the reporting and accountability mechanism that underpins the ECB’s independence.  The time to start is now.  I hope the European Commission and the European Parliament will press the issue.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website